Worries about debt, economy plague bond investors

ByABC News
October 15, 2008, 10:28 PM

— -- Pundits warning credit markets wouldn't be fixed in a day were vindicated Wednesday as bond investors found new things to worry about.

While the world's central banks have backstopped the financial system, that leaves bond investors to fret over the weakening economy and companies' ability to service their debt.

Fear over the financial strength of financial institutions rose 8%, eating away about half the improvement on Tuesday, based on Credit Derivatives Research's CDR Counterparty Risk index. Meanwhile, worries about the ability of companies with even the highest-rated debt to repay debt increased 9%, based on the CDR U.S. Investment Grade index.

"While we've made some progress, we've got a ways to go, and the market has realized that," says Mario DeRose at Edward Jones. The credit markets are "still in a state of real turmoil," says Michael Darda of MKM Partners.

Concern is well founded. The U.S. corporate default rate is expected to soar to a six-year high of 7.6% in the next 12 months, Standard & Poor's said Wednesday. The day's 733-point sell-off in the Dow Jones industrials shows confidence overall is still shaky, says Guy LeBas of Janney Montgomery Scott.

The market for debt issued by cities, states and other municipalities also is strained. While the appetite for California's sale of $4 billion in notes this week was healthy, the 4% to 4.5% rate for debt maturing in May and June is "pretty high," says Daniel Solender of Lord Abbett. Municipal bond yields remain elevated as investors look to cash in easily traded securities such as muni bonds, he says.

Traders are watching yields on debt issued by mortgage giants Fannie Mae and Freddie Mac, which remain high compared with government securities as investors move money into other areas of the credit market, including bank debt, that have gained government backing, says William O'Donnell of UBS Securities. O'Donnell calls this an "unintended consequence" of moves by central banks to support the financial system.